Small Business is a FARCE!!!

20 Aug, 2015 0 comments
Pawel Rzeczkowski Pawel Rzeczkowski

When billionaires who run global corporations wax poetically about virtues of small business you better believe that big global business is the business of our times.

In a globalized world, size matters
In 2011 Marc Andreessen famously started talking about the disruptive nature of technological innovation as “Software Eating the World”. Today, everybody, from entrepreneurs like me to VCs, along with the news media, is chasing Unicorns. And by unicorn, obviously I mean a startup with valuation above one billion dollars. Not small.

If we work backwards from this billion dollar unicorn valuation, and take the most absurd valuation of 20x revenue for a growing tech company, you would need $50M a year in revenue to support that $1B valuation. However, most small businesses are not growing tech companies and $50M is not a small amount of revenue.

Unicorns are global
It is important to note that as technology is shrinking our world, the conventional big businesses are becoming bigger and more global as they expand for growth abroad. Listed companies on average get 50% of their revenue from international sources. For tech companies that is 60% of their revenue and it’s growing. Let that sink in for a minute, 60% of US tech companies’ revenue comes from abroad. Just to be clear, that is more than half and that is not small.

The USA news tends to look on itself, but there is more to our world as the big companies found out. Unfortunately, in today’s capital-intensive world the opportunities that existed in the labor-intensive emergent industrial society in EU and US which created our middle class in the mid 20th century do NOT exist for the globalized masses in the Emerging Markets.

When people are talking about US companies holding more than $2 trillion in profits overseas, and just seven of the biggest tech companies account for a fifth of this, it is not just a result of tax shenanigans. It is where the growth opportunities are and where the business is: overseas.

The unicorns that we are all chasing are tech companies. Inherently, most tech startup’s are global from the get go. Facebook, Google, Pinterest and Uber are all global companies. We even compare our startups to countries not businesses: If Facebook were a country, it would be the most populous nation on earth. Facebook valuation at IPO was over $100 billion. That’s not small and everybody is trying to build the next Facebook-sized company: a company that has a small staff, impacts billions of people and makes billions of dollars.

What exactly is small business
The US Small Business Administration defines what constitutes small business by industry. Generally, it is a business with less than 500 employees or some annual revenue maximum. For a law office or a doctor’s office, the annual revenue maximum is $11M, for a dentist it is $7.5M, and for a construction company it is $36.5M, just to name a few. Not sure I would call 500 employees a small business. However, in comparison to McDonalds or UPS, who employ around 400,000 people each, one could draw an arbitrary line at 500 employees.

The US Small Business Administration’s definition in terms of revenue and the number of employees really does not help us to frame an image of the elusive small business. The average person on the street imagines small business not much different than what an inhabitant of Paris or London would imagine it in the mid 1800’s. Back then, almost all of the businesses were small business. The corner store, the hairdresser, the butcher, the lawyer, the seamstress, the baker, and yes, the candlestick maker. All of it.

Historical perspective
As industrialization was spreading into the world from the late 1700’s UK, railroads that connected the emergent centers of manufacturing and the steel used for the railroads and manufacturing became our first big businesses. In 1901, US Steel became the first company with valuation over a billion dollars when JP Morgan refinanced it after he purchased it from Andrew Carnegie. We only went up in scale from there.

Slowly but surely, from the mid 1800’s, technology has been improving, railroad networks continued growing, manufacturing continued expanding and people’s lives were changing for the better. Over time all the small general stores started to be displaced by new and much bigger department stores. In the developed world, the idea of having many products and services under one roof took off and permanently reshaped peoples shopping habits.

One world
The pattern of increasing size, scale and scope continues today. Have you ever shopped at eBay or Every industry continues the quest for economies of scale. We have many global brands now. Coca Cola became the first global brand after WWII, but pick an industry, any industry, from manufacturing, consulting, software, banking, automotive, you name it, and you will find that today they are all completely global. I just went to a baby store in Cali Colombia to get new level 3 nipples for our Dr. Brown bottles, and a few Fisher-Price teether toys for my twins. You can buy all the same brands in Colombia and anywhere else that you find at Babies”R”Us in the US. Our twins are used to air-conditioning so we went to buy a room AC unit at a local equivalent to Home Depot. Again you can get the same brands as in the US: Whirlpool, Black&Decker, Bosh, Panasonic, Electrolux, you name it. When I needed an antibiotic, I had a choice of Pfizer or Abbot. The same story is happening in the world over. In Lagos, I was drinking Johnny Walker, blowing my nose into a Kleenex, and driving in a Toyota to the airport. The Chinese are famous for buying western brands despite the high prices, particularly, when it comes to taking care of their little emperors, their kids. You can buy Nestle products all over Latin America, including on the trail to Machu Picchu. And so forth and so on, this list could go on forever and extends into services as in Clifford Chance for legal or McKinsey for consulting.

Global mega corporation
The point is that whether you see it or not, more and more industrial and consumer goods and services are provided by global companies the world over. As a side note, executive compensation tends to be proportional to company size which explains some of the exec comp increases from the last three decades. But where are all the small companies which we started out with in the 1800’s? The Department Store displaced most of the specialty shops. Big Box retail epitomized by Wal-Mart displaced most of small city small businesses. And now Amazon goes beyond Wal-Mart. Global food franchises displace small restaurants. For example, that was very visible in NYC after the recession. The growth of Chipotle and Shake Shack epitomize that small restaurant demise. Both Chipotle and Shake Shack were listed with valuations above $1B. Not small. Just when you thought your taxi driver was local, Uber came in, a company with over $50 billion valuation. On a side note, I love having Uber in Cali Colombia as much as I love it in Brooklyn: makes life easier.

What’s left to be eaten up by software? We still have insurance agents and small wealth advisors all over the US. The robo-advisors are effectively displacing wealth managers as discount ticket agents such as Priceline displaced travel agents in the late 90’s. Insurance is not far behind and with the advent of the self-driving car, auto insurance will for a big part disappear from consumers’ lives. Healthcare, as practiced by independent doctors is still small business, however, the level of VC money going into that field makes me think that’s not for long. The classic argument for local business was that your plumber and your cleaning lady would both always need to be local. Well, there are Uber-like companies getting into this space as well, like Angie’s list and In Atlanta, there is HUX , however, Amazon is exploring getting into services as well. It’s the beginning of the end of local.

On the continuum from everything being a small business to everything being efficiently provided by mega corporations operating on a global platform, we are a little more than half way there. The monumental scale of the global business reality we live in is greatly misunderstood and vastly different than the romantic perception the term small business evokes in most people, even when billionaires themselves talk about small business.

The Numbers
I do not have numbers going back to the 1800’s, so I will look at the data available from the US Small Business Administration. From 1977 to 2012 the split between the number of small and big businesses has shifted marginally towards big business. The number of businesses with less than 500 employees grew at 1.5% annually, whereas the number of businesses employing more than 500 employees grew at 1.8%. The real split is at 100 employees. The number of firms with fewer than 100 employees kept track with population growth of 1% per year and the number of all bigger companies actually grew at 2% a year. That is a sustained and steady change. As of 2012 we are talking about 5.7 million small firms and 18 thousand big firms.

When we look at the employment numbers, more than half -or 52%- of the working population now works for big businesses, whereas, in 1977 more than half -or 54%- of the population worked for small businesses employing less than 500 people. On average, the big business employees make 30% more than the small business employees as of 2012. That gap was 27% in 1992. That demonstrates a steady growth and an impressive advantage of big corporations. However, that is partial information capturing only the US.

The small business numbers in US hide inside them the rise of the precariat, the increasing shift to freelance labor. Many of the freelancers operate as a small business under the US Small Business Administration, though not all. Nearly 1 in 3 working Americans is an independent worker, and that’s not explicitly captured in the numbers.

Although the number of big and small firms and the number of employees working for big and small businesses and their average salaries have shifted only marginally in favor of the bigger firms according to data available from US Small Business Administration, the big firms became massive global organizations. If we use S&P 500 as a proxy for the big firms, the market cap of the average S&P 500 company has grown at 10% a year for the past 38 years. In 1977, the average market cap of an S&P 500 company was $1.25B and today it is $40B. All the S&P 500 firms combined had a total market cap of $623 billion in 1997. Today it is $20 Trillion. Just for perspective, the total size of the US economy as measured by GDP is estimated to be $18 trillion this year. That is not small.

Technology and globalization are shrinking our world and creating unicorns in the land of ever increasing global corporations. Thus, Marc Andreessen’s statement “Software is Eating the World” has to be restated as: “Software is enabling big companies, old and new, to grow by eating small business everywhere.” This statement is perhaps not as sexy, but it is more descriptive and more accurate. Hence, small Business is a farce.

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So it’s a farce, now what? We need to address the reality of our emergent post-industrial world and not play up the importance of small business without acknowledging the structural challenges posed by the emergent reality of our connected globalized world. Preaching the gospel of small business without understanding those forces that are driving our post-industrial society is at best a harmful red herring and detracts from addressing the rise of global corporate entities that surpass in economic scale and power many countries. We can debate whether it is a good thing or a bad thing, and that’s a separate debate, but we need to have that informed debate.

Why I believe global tech companies are a net positive
Ironically, all this globalization with the Unicorns’ and mega corporations’ growth will have a counterintuitive and positive result on the nature of business. We are actually going back to relationship based businesses and will witness the slow death of the transactional culture. The transaction culture emerged as a result of the 1970’s deregulation and ensuing market competition. The return to the relationship culture is brought by the same technology revolution that is shrinking our world and creating unicorns. I am talking about the vendor and product review process on Amazon, Airbnb, the vendor review process on eBay, and about the behavioral change among all the global hotels and restaurants as a result of our reviews on TripAdvisor. I’m talking about all the Uber drivers and clients that review each other. Yelp and so on and so forth. Welcome to the new networked reality.

The humanizing Facebook/LinkedIn effect, that is, your identity being verified and permanently out there, will have a profound impact on how big business evolves as it eats small business. This is shaping positive changes in retail and in finance and all of business. I view it as an opportunity for the consuming public to get closer to the brands and service providers, and via this new feedback loop, help businesses serve us better with more relevant products as we continuously iterate in a more dynamic connected system. Many of the feedback loops connecting consumers to brands and corporations are business opportunities yet to be realized and yet to make our lives better. My professional and personal goal is to help connect the big businesses to big numbers of people and make the world a better place for all. That’s the idea behind Stocks You Love.

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